Chapter 14: Deficit spending and the public debt.

These chapter talks about how the U, S, government finances its deficit by taxing, or borrowing or creating (printing money). It talks about the debt, interest cost, and its burden on future generations.

Government financing the budget deficit: That is if government spending (G) exceeds taxes revenues (T), then there is a deficit which can be financed by issuing government bonds (by borrowing money). If the government borrows money this will lead to interest rate increase and crowd out of some private investment spending.

Decreases in private spending reduce the expansionary impact of the deficit spending.

The government can also finance its budget deficit by creating new money: If the government finances its deficit spending by printing new money, then there is no crowding out of private spending. That this spending will increase without reducing consumption or investment.

This kind of financing is a more expansionary way but more inflationary.

The third alternative is may be tax increase.

National debt is the total value of all outstanding Federal government securities:

The gross public debt is all Federal government debt. That is the total value of all outstanding federal government securities.

The net public debt is the gross public debt minus all government interagency borrowings.

In fact, the U.S. National debt, as a percentage of GDP, has risen since early 1980s.

Annual interest payment on National debt, as a percentage of GDP in early 1980s, and continued during the Bush administration but has fallen since then until budget surplus was achieved in 1999.

Foreign own about 16% of the U.S. public debt. The burden of the public debt tripled to about $4 trillion. Note that public debt is the total of all outstanding debt owed by the treasury to its individuals and institutional lenders.

Federal deficit, in fact, is a burden on the shoulder of future generations in two ways:

1. Future generations will be taxed to pay off the public debt that resulted from the present generation’s increased consumption of public goods.
2. The increased consumption by the present generation crowds outs investment and reduces the growth of capital goods. The future generations will have smaller capital stock and wealth.

How to pay of the debt?

Paying off the debt in the future by future generations may be inherent if we don’t pay now.

Future generations have to pay off the debt by increasing taxes.

The amount of debt to foreigners is the public debt owned by foreigners (16% of the total debt). If the debt owned by foreigners had been invested in useful projects then the d bet is not a problem. That is if the debt has been invested in productive projects, such as education which creates human capital in the future, or any other projects that yield a rate of return greater than the cost of the debt.

This will create net investment for the future generations.

There is a linkage between Federal deficit and foreign trade deficits because part of the money financed the budget came from abroad. When there is large deficit foreigners, who hold U.S. money will spend more on U.S. government securities, bonds and less on U.S. goods and services.

In the case of Surplus, the government should use the surplus by paying off the debt. This means that the government buys back some of its bonds and this will lead to a decrease in interest rate and an increase in private borrowing and spending. Therefore, the increase in private spending offsets the contractionary fiscal policy.

However, if the surplus tax revenues are not spent in the economy, then this will lead to more anti-inflationary impact of the contractionary policy.